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5 myths of international investing

If you hold any of these common misconceptions about international investments, it could cost you.

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The real story

  • In any given year, the best performing stock market is usually outside the US.
  • International diversification has historically improved risk-adjusted returns.
  • US-based multinationals may not provide adequate international exposure. 
  • Hedging currency risk doesn't always benefit investors.
  • Actively managed funds may offer potential outperformance in international markets.

The long-term rally in U.S. stocks has benefited many investors. However, it's also led some investors to have more of their portfolio devoted to U.S. stocks than they may have intended. Overexposure to a single geography breeds diversification risk in a portfolio, leaving it vulnerable to a downturn in that geography and underexposed to a rally in other parts of the world. With that in mind, investors may want to re-examine the global mix of their stock allocations, and consider increasing their international exposure if they’re too heavily weighted in domestic stocks. In fact, Fidelity customer data suggests that millions of investors may be under-exposed to international stocks.1

There are powerful reasons to invest outside the U.S., such as enhanced diversification, the potential for better risk-adjusted portfolio returns, and a larger opportunity set, among others. Nevertheless, many investors still lack international exposure, often due to misperceptions about the asset class. Here are five of the most common myths investors cite for not investing overseas, contrasted by what Fidelity believes are more realistic perspectives about the asset class.

Myth 1: The US is the world’s best-performing stock market

Reality: Not true. While U.S. stocks have had higher returns than overseas equities in aggregate for the past several years, the best-performing stock market for each of the past 30 years has been located outside the United States (The graphic above shows the best-performing developed stock market during the past dozen years). Historically, developed market international and U.S. stock performance is cyclical: One typically outperforms the other for several years until the cycle reverses (see chart). Timing these rotations is difficult, though, which is why it’s important to have both U.S. and non-U.S. exposure in an equity portfolio. Investors underexposed to foreign stocks could miss significant gains when overseas markets rally, or suffer losses when U.S. stocks decline.

Myth 2: International investing is too risky

Reality: International stocks in combination with U.S. stocks can actually lower risk in an equity portfolio, compared with an all-U.S. portfolio. That's because historically, the performance of U.S. and international stocks has not typically been perfectly correlated,2 which thereby reduces risk. Historically, a globally balanced hypothetical portfolio of 70% U.S./30% international equities has produced better risk-adjusted returns (Sharpe ratio) and lower volatility (standard deviation) than an all-U.S. portfolio (see table, below). Also, the absolute return of the globally balanced portfolio is almost level with that of the all-U.S. portfolio, despite the recent multiyear rally in U.S. stocks. And given the cyclicality of U.S. and foreign stock returns, history suggests their relationship could revert to its historical norms at some stage.

International equity exposure may decrease portfolio risk over the long term
1950 to 2016 U.S. Portfolio International Portfolio Globally Balanced Portfolio 70% U.S./30% Int'l
Annualized returns 11.2% 9.3% 10.8%
Standard deviation 14.3% 15.2% 13.2%
Sharpe ratio 0.47 0.32 0.49
Hypothetical “globally balanced portfolio” is rebalanced annually in 70% U.S. and 30% foreign stocks. U.S. equities: S&P 500® Total Return Index; International equities: MSCI ACWI ex-USA Index. Source: Bloomberg Finance L.P., Fidelity Investments (AART), as of Feb. 16, 2017. Past performance is no guarantee of future results. It is not possible to invest directly in an index. All indexes are unmanaged. Please see appendix for important index information.

Myth 3: US multinationals provide adequate international diversification

Reality: The stocks of large U.S. companies with operations overseas (multinationals) are sometimes highly correlated to the performance of the overall domestic stock market. Highly correlated stocks in a portfolio may indicate a lack of diversification. Therefore, U.S. multinationals are not always good replacements for international stocks for diversification purposes. The table below compares the average correlations of several U.S. multinationals to their foreign counterparts with U.S.-listed shares. The non-U.S. stocks shown have had lower correlations to the S&P 500 over the past three years, which typically signals better diversification benefits.

International stocks can provide more diversification benefits than U.S. multinationals
Three-year mega-cap correlations with the S&P 500, 2014 to 2016
Consumer staples
Procter & Gamble (U.S.) 0.45
Unilever (U.K.) 0.10
Ford (U.S.) 0.72
Hyundai Motor (So. Korea) 0.31
Oracle (U.S.) 0.73
SAP (Germany) 0.60
Source: Morningstar, as of Dec. 31, 2016. Company names shown here are for illustrative purposes only, are not representative of all companies, and are not a recommendation or an offer or solicitation to buy or sell any securities. Past performance is not a guarantee of future results.

Myth 4: One needs to hedge currency to improve international stock returns

Reality: Actually, history shows that hedging currency returns doesn't improve international stock returns—at least not over the long term. Currency hedging (holding a stock denominated in a foreign currency and an equal but opposite short position in the currency itself) is intended to prevent currency fluctuations from hurting the stock price. While it sounds good in theory, the time and cost it takes to hedge currency has not paid off over time. Since 1973, currency hedging has detracted from returns in 50% of quarters, and contributed to returns in 50% of all quarters (see chart).

Timing currency movements is extremely difficult, even for professional investors. Plus, currency tends to be a relatively small component of returns over time, especially compared to earnings growth and price-to-earnings ratio expansion. What’s more, on an aggregate basis, an unhedged strategy (MSCI EAFE U.S. Dollar Index) has outperformed a hedged strategy (MSCI EAFE Local Currency Index) by roughly 1% on an annualized basis since 1973.3

Myth 5: After fees, actively managed international funds don’t compete with passive strategies

Reality: Just the opposite is true. Historically, actively managed international funds have significantly outperformed their passive peers, even after fees. In fact, since 1993, the average actively managed large-cap international fund has beaten its benchmark index by 0.84% annually (see chart).4 In comparison, the average large-cap international index fund has trailed its benchmark by 0.31%. While averages can conceal significant variation between individual time periods and funds, that’s a difference of 1.15% per year (including fee impact) in favor of active funds. 

When it comes to equity performance, company selection is by far the biggest driver of returns—twice as important as country or sector selection. This gives larger active managers the advantage, because they have the resources and flexibility to select or avoid specific companies in an index, while many index funds are exposed to all companies—good and bad—in a particular investment universe.

Investment implications

For each of the past 30 years, the best-performing stock markets have been located outside the United States. That means investors who were focused solely on U.S. stocks missed out on attractive opportunities for growth and diversification. Historically, a globally balanced portfolio consisting of 70% U.S. and 30% international equities has provided competitive absolute returns, lower volatility, and better risk-adjusted returns than an equity portfolio consisting of just U.S. stocks.

Fidelity believes taking an active approach to security selection can be a compelling way to achieve favorable returns when investing internationally. So consider increasing your allocation to international stocks. It could make a world of difference in your portfolio.

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Fidelity Thought Leadership Vice President Matt Bennett provided editorial direction for this article.
1. Based on a Fidelity analysis of personal investing account data as of March 1, 2017. Domestic equity was measured as all domestic equity mutual funds and ETFs as per Morningstar and international equity was all international equity mutual funds and ETFs per Morningstar. Investor portfolios were compared to Fidelity target asset mixes to determine if an investor was under-exposed to international stocks.
2. See Glossary of Terms below.
2. FactSet, as of Dec. 31, 2016.
3. Fidelity Investments, "Some Active Funds Rise Above a Tough Year," March 2016.
Before investing in any mutual fund, please carefully consider the investment objectives, risks, charges, and expenses. For this and other information, contact Fidelity for a free prospectus or, if available, a summary prospectus. Please read it carefully.
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Glossary of Terms
Sharpe ratio compares portfolio returns above the risk-free rate relative to overall portfolio volatility. A higher Sharpe ratio implies better risk-adjusted returns. Standard deviation is a statistical measure of market volatility, measuring how widely prices are dispersed from the average price. A low standard deviation indicates that the data points tend to be very close to the average, and a high standard deviation indicates the data points are spread over a larger range of values. A higher standard deviation represents greater relative risk.
Correlation measures the interdependencies of two random variables that range in value from −1 to +1, indicating perfect negative correlation at −1, absence of correlation at 0, and perfect positive correlation at +1.
Price-to-earnings (P/E) ratio shows the relationship between a stock price and its company’s earnings (or profits) per share of stock.
Information presented herein is for discussion and illustrative purposes only and is not a recommendation or an offer or solicitation to buy or sell any securities. Views expressed are as of the date indicated, based on the information available at that time, and may change based on market and other conditions. Unless otherwise noted, the opinions provided are those of the author and not necessarily those of Fidelity Investments or its affiliates. Fidelity does not assume any duty to update any of the information.
Investment decisions should be based on an individual’s own goals, time horizon, and tolerance for risk. Nothing in this content should be considered to be legal or tax advice and you are encouraged to consult your own lawyer, accountant, or other advisor before making any financial decision.
Stock markets, especially non-U.S. markets, are volatile and can decline significantly in response to adverse issuer, political, regulatory, market, or economic developments. Foreign securities are subject to interest rate, currency exchange rate, economic, and political risks, all of which are magnified in emerging markets.
The securities of smaller, less well-known companies can be more volatile than those of larger companies.
Growth stocks can perform differently from the market as a whole and from other types of stocks, and can be more volatile than other types of stocks. Value stocks can perform differently from other types of stocks and can continue to be undervalued by the market for long periods of time.
Investing involves risk, including risk of loss. Past performance is no guarantee of future results. Diversification and asset allocation do not ensure a profit or guarantee against loss.
All indexes are unmanaged. You cannot invest directly in an index.
Index definitions
Standard & Poor’s 500 (S&P 500®) Index is a market capitalization–weighted index of 500 common stocks chosen for market size, liquidity, and industry group representation to represent U.S. equity performance. S&P 500 is a registered service mark of The McGraw-Hill Companies, Inc., and has been licensed for use by Fidelity Distributors Corporation and its affiliates.
MSCI All Country World Index ex-U.S. is a free float–adjusted market capitalization–weighted index designed to measure the equity market performance of developed and emerging markets, excluding the U.S.
MSCI Europe, Australasia, Far East Index (EAFE) is a market capitalization–weighted index that is designed to measure the investable equity market performance for global investors in developed markets, excluding the U.S. & Canada.
MSCI Emerging Markets (EM) Index is a market capitalization-weighted index designed to measure the investable equity market performance for global investors in emerging markets.
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